Choice of Entity
6 Factors as applied to LPs: a) 1. Liability →
(1) *As to the GPs of the LP → they are jointly & severally liable for the ALL unpaid bills/debts of the LP* (a) In exchange → GPs get full control and management of the business (2) *As to the LPs of the LP → they have limited liability* (a) = may lose their investment, but are not liable for more than that! (also whatever he/she has contractually committed to the partnership) (b) → their personal assets are safe (c) "Here's my money, go make me more money"
6 Factors as applied to LPs: a) 2. Control →
(1) *As to the GPs of the LP → they get full control and management of the business* (2) *As to the LPs of the LP → they give up power to manage & control!* ---(a) Gives up any meaningful participation in management and control in exchange for limited liability. This is known as the CONTROL RULE ---(i) → LP cannot meaningfully participate in management and control; can be deemed a de facto general partner if they cross the line (Gateway).
6 Factors as applied to Companies: 4. Continuity of Existence →
(1) *DEFAULT = Corp. has perpetual existence* (2) Corp. charter may include an expiration date, but still that may be amended later on
(a) Hypothetical: 3 partners with no partnership agreement. Partner A contributes 90%; Partner B contributes 5%; Partner C contributes 5%. $90,000 profit. How do we distribute profits?
(i) UPA 18(a) (ii) RUPA 401(b) (iii) 1/3 to Partner A: $30,000 (iv) 1/3 to Partner B: $30,000 (v) and 1/3 to Partner C: $30,000. (vi) Bad deal for Partner A Should have completed a partnership agreement.
*2. General Partnership* What if the parties have in writing that "no partnership is being formed here by _____" ??? → Need a formal partnership agreement before it exists?
* = writing is NOT dispositive, it is just evidence thereof* *No, however, it is best business practice to have one in writing* RUPA § 102(12): agreement, whether oral, implied, or in writing Hilco Prop. Services v. U.S. = *Need to look at totality of circumstances which will confer the factual question.* -Written agreement is not dispositive, but will carry evidentiary value -Takeaway: Better to put your agreement in writing
6 Factors as applied to SPs: 6. Capitalization: a SP may finance via a...(3)
-A personal loan, or borrow from friends or family -With your own personal assets -Crowdfunding (so long as not offering ownership) - *NOTE* → if you bring a partner, you will most likely destroy the SP
(1) Debts incurred BEFORE you become a Partner (2) Debts incurred WHILE you are a Partner (3) Debts incurred AFTER you leave/withdraw the GP
1. (a) You are NOT liable for those debts, except that your investment may be used to pay previous debts 2. (a) You are jointly & severally liable for those debts 3. (a) You are NOT liable for those debts (b) *To withdraw → must do so in writing AND give your managerial attributes*
6 Factors as applied to SPs: 1. Liability
1. Liability → *if the business can't pay, the owner of the SP is unlimited and personally liable → "unlimited personal liability"* Because there is no legal distinction between Jane and Castle Town Photos, they are the SAME legal entity ⇒ *all business assets = personal assets, & therefore, her creditors are able to claim those assets* How to manage risk? -SPs may seek insurance, for this reason -May also seek a creditor to contract to only accessing some of your assets
6 Choices of Entities for Persons creating a Business:
1. Sole proprietorship 2. General partnership 3. Limited partnership 4. Limited liability partnerships 5. Limited liability company 6. Corporation (S Corp. v. C Corp.)
6 Factors as applied to LLCs: 3. Transferability
a) *like a GP (1) You are entitled to transfer your "financial attributes" without others permission *(unless the operating agreement says otherwise) BUT *(1) You will not get managerial control UNLESS the members agree* (i) *default rules* → a transferee won't receive the managerial attributes of the transferred membership interest unless and until all the remaining members vote in favor of it (a) —i.e., the *remaining members must unanimously vote in the transferee as a full-fledged member with managerial rights.*
6 Factors as applied to LLCs: 1. Liability
a) → *like a corporation → ALL OWNERS of the LLC have limited liability* (1) = may lose your investment, but your personal assets are not the hook for unpaid (2) Owners of the LLCs called "members" (3) NO ONE is J&S liable!
6 Factors as applied to LLCs: 2. Control = 2 ways!
a) → 2 ways for an LLC to be controlled (1) *Either → a. DEFAULT ⇒ same as GP: all members have the same amount of control* UNLESS the operating agreement says otherwise (a) = "member-managed" (2) *or b. Operating agreement = typically place the managerial control in 1 or 2 members → managers* (a) = "manager-managed" (b) Then, the other members get the benefits of a LPs of a LP, like a passive partner (3) Articles of Organization may change the default. ---(a) However, management is usually set forth in operating agreement. (Along with governance, transferability, and the death of a member).
6 Factors as applied to LLCs: 6. Capitalization
a) → similar to a GP (1) Can issue different membership interests...different voting rights, etc. (2) Very flexible -----(a) This is an advantage over the S. corp. → S. corp. can only issue shares of common stock, must keep S. corp. Standards
6 Factors as applied to GPs: 2. Control → DEFAULT RULE → Control and Martin v. Peyton?
DEFAULT RULE → *each partner has an equal say in the management and affairs of the partnership, unless otherwise states* - *EVEN IF a given partner made a greater financial commitment* to the partnership than the other partners (1) Martin v. Peyton (a) *Right to participate in control of the business is the essence of co-ownership.* (b) Court objectively looked at the loan between defendant Peyton and the company K&K and held that was merely a loan. (c) Defendant would advise the company; inspect the books; option to enter the firm at a later date. *This passive management did not transform the creditor into a partner.*
6 Factors as applied to GPs: 2. Control & Voting (a) Summers v. Dooley 2 person garbage collection business where 1 partner hired a new employee in disregard of the objection of the other partner. valid?
In the absence of a partnership agreement → default rules (a) Law in the state = "Any difference arising as to ordinary matters connected with the partnership business may be decided by a majority of the partners. . . . " (ii) *An equal partner in a two-man partnership (garbage collection business) did not have the authority to hire a new employee in disregard of the objection of the other partner.*
6 Factors as applied to Companies: 1. Liability -exception?
→ *shareholders have Limited Liability!* (1) Because the company is a separate legal entity → shareholders are NOT J&S liable (2) Shareholders may lose their investments, but their personal assets are shielded from creditors of the company (3) *NOTE a caveat→ "piercing the corporate veil"* = Certain circumstance where shareholder doesn't get limited liability
6 Factors as applied to Companies: 3. Transferability
→ *shares of stock are considered PERSONAL PROPERTY → therefore that is freely tradable* (1) *Exceptions* → some closely-held corps have a shareholders agreement that restrict the transferability of those shares
6 Factors as applied to GPs: 5. Taxation → -what issue?
(1) = *GPs are a flow-through or pass-through tax entity* (a) = on an annual basis, all the taxable items are *allocated* to the individual partners, who then individually pay the tax on them through their own income tax forms (a) *Allocations: GP must allocate to each partner their share of taxable items, required by law* (i) But, this is NOT a distribution = NOT $ IN HAND! (b) *Distributions: given by GPs = is money in hand* (i) *Not taxable, BECAUSE taxes already paid through allocations* (ii) Are discretionary, decision of the GP (iii) Essentially = this may be the profits that have already been "allocated" for tax purposes & now GP wants some of the Ps to share in the income (a) However, the GP could decide instead to give no distributions to the Ps and reinvest the profits in the business *Problem: Allocation listed on K1 does not always represent the amount of money distributed.*
6 Factors as applied to LPs: a) 3. Transferability → b) 4. Continuity of Existence → c) 5. Taxation → d) 6. Capitalization →
(1) = same as GP!
6 Factors as applied to LLCs: a) 4. Continuity of Existence →
(1) Events of dissolution → events of disassociation (a) = *When one such event occurs, the remaining members must decide whether to continue the LLC, albeit in a slightly altered form, or to wind up the LLC's affairs and terminate the LLC.* (2) *To end → need to file with the state again*
6 Factors as applied to GPs: 6. Capitalization →
(1) Loans (2) Taking new Partners -----(a) → DEFAULT: need unanimity to do so
6 Factors as applied to Companies: 7. Transparency: Public vs Private?
(1) Publicly-Traded Company: As a "reporting company" under the Exchange Act, the company must file periodic reports (e.g., 10-Ks, 10-Qs, proxy statements, etc.) with the SEC which provide detailed information about the company to the public. (a) Live in a "glass house" (2) Privately-Held Company: Company information is proprietary (=private) and will only be released if the company consents.
6 Factors as applied to Companies: 6. Capitalization → Publicly-Traded Company? Privately-Held Company?
(1) Publicly-Traded Company: Shares are sold to the public through an IPO registered with the SEC pursuant to the Securities Act. (2) Privately-Held Company: Shares are sold privately to investors through one or more exemptions to registration under the Securities Act. (3) *C Corp → GREAT flexibility here...may offer the following* = Three types of basic financial securities: (a) common stock; (b) preferred stock; (c) debt securities
a) If you are the victim of malpractice→ and win $100 million judgement
(1) They'll have malpractice insurance (2) Also get the $ of the assets invested in the LLPs (3) If still not enough, go for the personal assets of the individual partner who committed the malpractice, but that is as far as your can go!
Let's assume that a flow through tax entity (either a partnership, LLC or S corp) with 10 equal owners makes $1 million in pre-tax profit while a plain vanilla "C" corporation with 10 equal shareholders also makes $1 million in pre-tax profit. Also assume the C corporation pays out all of its after-tax profits to shareholders at the end of the year in the form of a cash dividend. Lastly, assume that the top income tax rate on corporate dividends is 20%, the top individual income tax rate on income is 37.0%, and the top corporate income tax rate is 21%. *Which group of owners winds up with more cash in their pockets after Uncle Sam is paid?* (1) Assumptions: (a) • Owners: 10 equal owners (b) • Entity pre-tax profit: $1 million (c) • All after-tax profits paid to owners of "C" Corp (d) • Corp Div tax rate: 20% (.2) (e) • Individual tax rate: 39.6% (.396) (Obama); 37.0% (.37) (Trump) (f) • "C" Corp tax rate: 35% (.35) (Obama); 21.0% (.21) (Trump)
(2) See calculation chart in docs → *More money in pocket with S Corps (avoiding double taxation!)*
*5 Necessary qualifications to become an S Corp:*
(a) *ALL shareholders must sign and consent* (b) *1. It has no more than 100 shareholders.* (c) *2. Its only shareholders are individuals (real people), estates, exempt organizations* (like another S Corp) described in section 401(a) or 501(c)(3) [of the Internal Revenue Code (IRC)], or certain trusts described in section 1361(c)(2)(A) [of the IRC]. . . . (d) *3. It has no nonresident alien shareholders.* ( 3 yr analysis) (e) *4. It has only one class of stock → Common stock* (May have different types of common stock) (f) *5. It cannot be the subsidiary of a C-Corp company (parent company)* ----(i) NOTE → the S Corp can invest in a C Corp without losing S Corp status
6 Factors as applied to GPs: 2. Control & Relationship between Partners in a GP: Meinhard v. Salmon (i) M and S were partners (ii) When S was approached for another deal, S did not involve M in it
(a) *Joint adventurers, like co-partners, owe one another, while the enterprise continues, the duty of the finest loyalty.* (b) UPA & RUPA → involve fiduciary duties that partners owe to one another (i) UPA - *Can't eliminate duty or define fiduciary duty as no fiduciary duty* (ii) Hold $ in trust for the benefit of the partnership (iii) The *partnership agreement may alter these obligations so long as they are not manifestly unreasonable*
6 Factors as applied to Companies: 2. Control (1) independent vs. management directors
(a) *Management* = officers that are also on the board of directors (i) Concerns that you may be biased, not want to vote against the CEO, who is on the board too and your boss (b) *Independent* = no connection other than being on the board
(a) Old ULPA: ? (b) New ULPA: ? (d) WHAT CONTROLS NOW?
(a) *Old ULPA: Follows Control Rule:* If you take part in the control of the company you will become a de facto partner (b) *New ULPA: No Control Rule:* Limited partners could be actively involved in the management of the company and still not lose their limited liability (wanted to compete with LLC) (c) Limited Partners give up management and control Passive Managers only ----(i) When limited partners engage in active management, they may be considered GP: (i) Mostly *OLD including NY and DE*
Corporations...as a separate legal entity...ENTITY POWERS & Constitutional Rights -7
(a) *Powers to sue, be sued, commit a crime, subjected to income and other taxes, etc.* (b) Constitutional Rights? -(i) Robust *EPC and DPC rights* (and no taking of property without just compensation) -(ii) Can invoke attorney client privilege -(iii) CANNOT plead to 5th -(iv) NO right to privacy -(v) 1st Amendment rights generally? ----(a) Yes, Robust first amendment rights, with regular limits -(vi) Defamation? ----(a) Yes, can be sued by corporation for defamation ----(b) Corp can sue another for defamation
(i) Andy, Betty and Charlotte decided to form a general partnership to pursue their dream of providing concierge services to pampered pets. *Andy put in 60% of the money, or $120,000. Betty and Charlotte each put in 20% of the money, or $40,000 each.* Thus, the total capitalization of the general partnership-called Pampered Pets-was $200,000. While the three partners had intended to enter into a formal partnership agreement, that ultimately fell through the cracks. They just got too busy with the business to focus on the legal paperwork. Assume Pampered Pets operates in a UPA state. (i) The business of Pampered Pets took off in a flash, as pet owners really open their pocketbooks for their pets! In fact, during the first full year of business, Pampered Pets earned $100,000 in profit (hooray!). (i) The three partners are trying to decide how much of the $100,000 profit, if any, should be distributed to the three partners. Betty and Charlotte would like all $100,000 to be distributed, as they could really use the money. Andy, the more affluent of the three partners, believes that only $50,000 should be distributed, with the remaining $50,000 being used by the partnership to self-finance the partnership's growth. *Which partner(s) will get their way and why?*
(a) Betty and Charlotte will win (b) UPA § 18(e): absent written agreement, equal voting power regardless of the amount of $ investment, and majority vote wins
(1) How to minimize the GP's liability? (i) HOWEVER → does a GP that is a Corp. shield you from liability in a case of breaches of fiduciary duties?
(a) Have the GP be a Corporation! ---(i) And then you are the sole stockholder of the corp. & get to call the shots of the Corp. & the LP! ---(ii) = shields you and your personal assets (a) NO (b) In Re USA Cotes Litigation Corporation as a GP will protect you from creditors, but you will not be shielded individually for breach of fiduciary duties.
(i) Assume the three partners reach a consensus that $60,000 of the $100,000 profit should be distributed to the partners. How much will each of Andy, Betty and Charlotte receive and why?
(a) They will receive equal portions of the $60k (b) UPA § 18: absent written agreement, equal distributions to each partner
(a) Practice Problem: (i) A and B want to enter into a GP. In order to get a loan, the bank requires both parties personal financial information (a) A refuses to b/c feels like its an invasion of privacy (b) B sues A for breach of fiduciary duty (ii) What result?
(a) → answer in Sanchez v. Saylor
Sanchez v. Saylor (i) Ed. Sanchez and Saylor were partners (ii) Sanchez to provide his personal financial statements as a condition to granting the loan, and Sanchez refused to furnish the statements. (iii) Saylor brought suit against Sanchez on the ground that Sanchez's refusal to provide his financial statements to the potential lender violated his fiduciary obligations as a partner of the partnership.
(i) *"neither partner had the right to impose his will or decision concerning the operation of the partnership business upon the other."* (ii) *business differences must be decided by a majority, not by one of two equal partners when the other objects.* (iii) absent an enforceable agreement covering such circumstances of disagreement, (iv) *when both partners in a two-partner partnership disagree on an advantageous prospective business transaction, it is dissolution, not an action for breach of fiduciary duty, that is the appropriate avenue of relief. . .* (v) → aka, if you don't agree, break up the GP...can't sue on these grounds for their compliance
6 Factors as applied to LPs: a) 2. Control → (a) Gateway → *3 key takeaways* (i) Argue that GBIC (limited partner) engaged in active management and control and thus should be liable like a general partner. LP was in office 3-5 days per week; all decisions had to be approved; and sometimes would even sign checks.
(i) *LP can be GP at same time → Thus, can be J & S liable* (ii) LP has rights and powers as a LP, and can exercise powers without fear of losing limited liability ---(a) *There are things that they can do in old ULPA 303(b) → SAFE HARBOR* -----(i) Ex: can be contractor, or employee. Can also consult or advise with respect to the GP business ------(ii) Can request and attend meetings of partners Vote, etc. (iii) *But, can also go too far if you act like a GP → Will be de-facto GP and be held to J&S liability* (a) This becomes the issue, whether or not they have crossed this line
(a) A. Debt securities? -what? -risk level?
(i) Bonds, debentures or notes (vi) *IOUs to investors...C will pay interest on* (vii) At the end of the period, the company will pay you back the principal (viii) Rights & benefits of this stock are set forth in a written document → contract claimants (not ownership) (ii) Risk Level? *Least risky because they are first in creditor line to get paid* ----(iii) First in line → secured creditors → lower interest rates ---(iv) Last in line → subordinate creditors (junk bonds) → Accept higher interest rates (v) If company is wildly successful does the debt holder get higher interest rates? NO. (a) Example: *$1000 principal; 5% interest; 30 years. $50 per year for 30 years and then after 30 years you owe the original $1000 principal.* (b) i. *Bonds:* Long term IOUs (usually 30 years) = Secured debt obligations, if company cannot pay back bond holders, holders may take assets (c) ii. *Debentures*: Also, long-term, traditionally not collateralized (unsecured), depends on company to pay back. Contract is called indenture (d) iii. *Notes*: Short term IOUs (3-8 years). Less risky. May or may not be secured; contract called note agreement
(a) B. Preferred stock -what? -risk level? -preferences?
(i) Hybrid security → some common stock features & some debt-like security features (ii) Rights & benefits of this stock are set forth in a written document → contract claimants (not ownership) (iii) Risk level? *Riskier than debt securities but not as risky as common stock* (a) After all the creditors get paid out in liquidation, then they get paid (a) *1. Dividend preference* = preferred stockholders get paid dividends before common stockholders (b) *2. Liquidation preference* =preferred stockholders get paid their Liquidation preference(set amount in K, usually what you paid for the share in the first place) + plus any accrued or unpaid dividends ALL BEFORE common stockholders get anything
(a) C .Common stock -what? -risk level? *(1) Creditor Hierarchy (Who gets paid first?)*
(i) Ownership claimants (ii) Stand LAST in line if the company liquidates, but they'll get everything left (residual in nature) (a) Most risky (iii) Bottom of the repayment food-chain (a) *1. Creditors* ---(i) a. Secured ---(ii) b. Senior ---(iii) c. Subordinated debt holder (agree to be last in line, but get higher rate of interest and return) (b) *2. Preferred Stock* (c) *3. Common Stock*
6 Factors as applied to GPs: 3. Transferability - 2 different components
*"Pick your Partner" Principle* Absent a partnership agreement → UPA & RUPA (a) *allow an existing partner to transfer the financial attributes (and ONLY the financial attributes) of her partnership interest, but managerial may not transfer without the agreement of other partners* (i) Financial interests = her right to share in profits and losses and to receive distributions of assets (most typically cash) (a) = as the financial attributes of a partnership interest are considered personal property. (ii) *If do so → the transferor is STILL jointly & severally liable for the debts of the GP* (a) *Transferor is still technically a partner, and has managerial control* (b) ⇒ RUPA 503(f) (b) The managerial attributes of a partnership interest (the right to participate in the management and affairs of the partnership) are a whole other ball game (i) DEFAULT (UPA § 18(g)) = *a transferee won't receive the managerial attributes of the transferred partnership interest unless and until all the remaining partners vote in favor of it UNANIMOUSLY*
a) MAJOR DISTINCTIONS BETWEEN PUBLICLY-TRADED AND PRIVATELY-HELD COMPANIES - when it comes to Control (i) 141(a): DE managed by the board of directors (and no age req.) (ii) 701: NY managed by BOD, all at least 18 yrs old
*(1) Publicly Traded Companies...* = *(a) Separation between ownership and control exists, as most shares are held by investors who are not directors and officers.* (i) the power to manage the business of a corporation is legally vested in the board of directors. Although in practice much of that power is exercised by the corporation's executives. (ii) Shareholders have NO right to participate in management *Vs. Small/Closely-Held Companies...* (a) *Tends to be a unity of ownership & control *(=stockholders are often directors and officers as well) (b) They open up in the morning & close at night → and call the shots
6 Factors as applied to GPs: 2. Control Lupien v. Malsbenden Lupien contracted with York Motor Mart for an automobile. Owner of YMM left the country. Lupien sues Malbenden arguing M overstepped boundaries as a creditor. On top of loan, M opened up the business each morning; had the final say on purchases; paid for business expenses with a personal check. *Takeaway?*
*(a) This active management transformed the SP of YMM into a GP and opened Malbsenden up to J&S liability.* (1) Martin v. Lupien (a) = difference of CONTROL (i) M had less control over the business than L did
6 Factors as applied to GPs: 4. Continuity of Existence → "Events of Dissolution" (UPA § 31) 4
*If one of the following occurs, the remaining GPs have a decision to proceed with the GP, or call it quits:* (i) death of a partner, (ii) the incapacity of a partner (thus preventing her from carrying out specific responsibilities on behalf of the partnership), (iii) the bankruptcy of a partner, (iv) or the desire of a partner to withdraw from the partnership. *→ if decide to call it quits* (a) 1. Winding up the GP's affairs (i) Stop new business (ii) Plan to liquidate the assets (iii) Pay the creditors (iv) Distribute remaining $ to partners according to the agreement or pro rata, if no agreement or (b) 2. Termination
6 Factors as applied to Companies: 2. Control
*controlled by the BOARD OF DIRECTORS* (1) *Board is appointed by the shareholders* (2) On a *day to day basis? → executive officers* (a) below the board, and CEO selected by the board of directors, & will approve the other officers that the CEO picks (b) CEO = chief exec officer (c) CFO = chief financial officer (d) COO = chief operating officer (e) CIO = chief information officer (f) President (g) Vice president (h) General counsel
6 Factors as applied to GPs: 1. Liability a. Can a personal creditor go after another partner's business assets?
*if the partnership can't pay, each partner would be joint & severally liable for the debts of the partnership* = *joint & severally liable* = if one partner is unable to meet their burden of the debt, the other partner will be held liable for the remaining sum owed -Such partners held liable for more than their share have a *claim of contribution against their partners who did not contribute* *NOTE → a newly admitted partner is NOT liable for debts of the partnership occurred BEFORE you joined the partnership* ---Governed by UPA 17 + RUPA 306(b): Only your investment in the partnership will be held liable for debts incurred before you joined the partnership To limit liability of the partners → partners may get insurance, like SPs a. *No, because the GP is a separate legal entity* BUT, your own partnership stake is a personal asset for which a creditor may secure a lien against
2. General Partnership -what? -how formed?
*is an "association of two or more persons to carry on as co-owners a business for profit."* UPA 6(1): RUPA 101(6): *NOTE = the parties in the GP NEED NOT subjectively intend to enter into a GP* -RUPA 202(a): The association of two or more persons to carry on as co-owners a business for profit forms a partnership, WHETHER OR NOT the persons intend to form a partnership. *governed by mostly DEFAULT statutes, some mandatory* → RUPA § 105(c)(1)-(17): a partnership may NOT... → RUPA 103(b): Cannot restrict partners' access to the books and supersedes any agreement otherwise
*5. Limited Liability Partnership (LLPs)* -what? -creation? (4)
*is traditionally an entity used by professionals = LLPs afford protection to professionals from potential malpractice claims asserted against their fellow partners.* (1) Essentially the same as GP except for malpractice claims b) LLP partners are, in most states, *STILL J&S liable for general unpaid bills of the LLP* c) *BUT → they are NOT J&S liable for the malpractice committed by your fellow partners!* (1) All assets of the partnership are exposed. Malpractice suit can reach company assets and the wrongdoing partner, but not the other partners. (a) RUPA 306(c) → minority = limited liability completely creation: (1) = LLP, all the partners of an existing general partnership *must vote in favor of creating a LLP* (2) Then a *state filing ( "Statement of Qualification" )* (3) Need a *minimal amount of malpractice insurance* (statutorily set) (4) Modify your *name to include, LLP at the end*
6 Factors as applied to LLCs: 5. Taxation a. Multi-member LLC? b. A single-member LLC?
*the IRS has largely decided to tax the LLC as a partnership, BUT giving each LLCs the option to be taxed as a corporation* (1) *Multi-member LLC are, by default, taxed as partnerships unless they elect to be taxed as corporations* by filing IRS Form 8832 (a) most LLCs are taxed as *flow-through or pass-through tax entities just like partnerships.* (allocation vs. distribution issue) 2. *A single-member LLC by default-disregards a single-member LLC and treats the single-member LLC as a sole proprietorship for tax purposes only* (b) possible for the single-member LLC *to avoid the default designation and instead choose to be taxed as a corporation by filing IRS Form 8832. (i) → the LLC can make an affirmative election under Subchapter S* of the IRC to be taxed as a so-called S Corp = *flow-through taxation*
6 Factors as applied to SPs: 2. Control 3. Transferability 4. Continuity of Existence → several ways to end a SP...(6)
2. Control → the SP! -Gets to call all the shots -Still may have employees 3. Transferability → a SP may sell the SP by selling ALL assets related to the SP = "asset deal" =Physical assets, intellectual property, etc. 4. Continuity of Existence -Simply close the SP -The SP dies or becomes incapacitated -SP files for personal bankruptcy -Selling the SP's assets -Brings in another owner (intentionally or unintentionally) creating a Partnership! -SP decides to form a Corp. instead
*7. The Corporation / Company* -what? -formation?
= *Corporations are artificial persons and creatures of statute formed under the general incorporation laws of a particular state.* ----Owners of a corporation = "shareholders/stockholders" FORMATION a) = similar to forming a limited partnership and an LLC in that *a state filing is required.* b) Someone associated with the new business (which can be the business' attorney), referred to as a sole incorporator, will prepare and sign a Certificate (sometimes called Articles of Incorporation) and then file it with the state (1) A.k.a. → Corporate Charter (2) ⇒ put members of the public on notice that the owners of the new corporation (referred to either as shareholders or stockholders) enjoy limited liability.
*6. Limited Liability Company (LLCs)* -what? -formation?
= *Limited liability companies are non-corporate entities that are created under statutes that combine elements of corporation and partnership law* a) *Filing at the state level* (1) NYS → file Articles of Organization with the state NOTE → LLCs are able to be used by Lawyers BUT only if the state allows it
*1. Sole Proprietorship (SP)* -what? -how formed?
= *a business that is owned & operated by ONE person* *Only 1 person can own a SP* -If another person joins → most likely create a general partnership (#2) *2 things needed → a business & a human to own and run it* -VERY EASILY CREATED, possibly without even knowing it -SPs may have employees ----Careful → if employee given a great deal of control, they may inadvertently convert it into a GP *No state filings needed to form a SP* *HOWEVER → if you want the business to operate under a fictitious business name, like "Castle Town Photography" ⇒ need to/should register as a "D/B/A" ("doing business as") at the state or local county in which she operates* register her SP as "Jane Smith d/b/a Castle Town Photography"
6 Factors as applied to Companies: 5. Taxation
= *subject to ENTITY-LEVEL income tax* (1) *Double Taxation:* A corporate firm is taxable on its income. Accordingly, if the firm has income or expenses, or gains or losses, those items go into the firm's taxable income, not into the taxable income of the firm's owners. (2) *They are sep legal entities, and therefore need to pay a separate income tax* (3) Most taxed as "C Corp" → Form 1160 ----(a) Today the max is 21% (4) *May elect to qualify as a "S Corp" → in order to be taxed as a flow-through entity* (a) To try & do so, must file a 2553
*Problem: Allocation listed on K1 does not always represent the amount of money distributed.* (a) Example: Million-dollar profits; (i) 20% to you; (ii) K1 will say $200,000. (iii) Here, you will be taxed for the $200,000 of profits recorded on K1. (iv) *But what if partner says he wants to return 1 million to finance the company's growth?* (b) Solution?
= Then you are paying taxes on money that was not distributed. (a) Solution? Partnership agreement will state that the partnership will do its best to distribute at least enough cash to cover taxes.
*3. Joint Venture* -what? 6 Factors as applied to JVs: a) 1. Liability → b) 2. Control → c) 3. Transferability → d) 4. Continuity of Existence → e) 5. Taxation → f) 6. Capitalization →
= is a *business arrangement in which two or more parties (think partners) agree to pool their resources for the purpose of accomplishing a specific task.* Laws of most states treat these the same as General Partnerships a) A key *distinction is that a joint venture has a specific purpose, and once this purpose is achieved the joint venture ends.* 6 Factors as applied to JVs: = *Go back to GPs! All the same*
*4. Limited Partnership (LP)* -what? -how formed? -4 distinctions from a GP?
= it is a *partnership formed by two or more persons under the laws of the state in question and having one or more general partners and one or more limited partners.* = a *state filing is needed* to initiate the limited partnership's de jure existence; ----ULPA §201 Formation Requirement: File certificate of limited partnership with the secretary of state. a) (a) a *state filing is needed* to initiate the limited partnership's de jure existence; b) (b) the *limited partnership must have at least one general partner and one limited partner;* c) (c) a *limitation on the liability shouldered by the limited partner exists;* d) and (d) a *limitation on the amount of control a limited partner can exert over the business exists.*
6 Factors to Consider when Choosing an Entity:
Liability (who is responsible for the bills if the business can't pay) Control (who gets to call the shots) Transferability (are you allowed to transfer/sell your ownership stake?) Continuity of Existence (how long can the business last? The life span?) Taxation (how will this business may tax on its income?) Capitalization (how easily can this business raise $ when needed in the future?)
6 Factors as applied to GPs: 1. Liability Martin v. Peyton Plaintiff argued defendant creditor was an implied manager via the defendant's participation and management of the business. Plaintiff creditor could not sue owner of business who was bankrupt, so sued defendant creditor as a partner to hold him jointly and severally liable. Court found that defendant's agreement was typical of a creditor's agreement and did not imply that the defendant was a creditor. Look at? (4+) what about sharing in profits?
Look at the surrounding circumstances -How they acted -How they interacted with others -Any writings -Sharing of profits Etc. Ds share of the profits → UPA 7(4) RUPA 202 (c)(3)(5) = talks about receiving a percentage of profits - *Receiving profits implies you are a partner/ If you are entitled to cut, you are a partner* *EXCEPTION: if your % is arranged in repayment of a loan you gave* (aka a % given to a creditor will not be presumed as evidence of a GP) ---This is where the Ds in Martin came in
6 Factors as applied to SPs: 5. Taxation
SP will file a Schedule C (see printout in binder) → then Schedule 1 (see printout) → then a 1040 Personal Income tax form(see printout) SPs need to pay taxes QUARTERLY! NOTE ⇒ if you have day job AND a SP and you have losses in a SP, you are allowed to net those losses against your other income and pay less taxes BUT → the IRS is weary of SPs and people using them to get tax deductions for hobbies -- o Must claim profit 3 out of first 5 years o Need profit motive *If it's a hobby* = only able to deduct/write for the amount you are bringing money in $10,000 income for the hobby of Pokemon trading cards, but spent $18,000 → can only write off the $10,000 in loses *However, if it's more a BUSINESS & you should a profit in 3 of the first 5 yrs* → you get to write off all business expenses and losses
6 Factors as applied to GPs: 2. Control *VOTING → Default Rules*
UPA §18(h)/RUPA § 401(j): Any difference arising as to *ordinary matters connected with the partnership business may be decided by a majority of the partners*; *BUT no act in contravention of any agreement between partners may be done rightfully without the consent of all the parties.*